Commentary

Never a Right Time to Tax Internet

By Stephen Moore
This article was published in the Washington Times, May 5, 2004.

Finally, a victory for the taxpayer. At least a partial one. Last week the Senate approved compromise legislation crafted by Sen. John McCain, Arizona Republican (yes, Mr. McCain was on the side of the angels), to extend the ban on Internet taxes four years through 2008. President Bush and Sen. George Allen, Virginia Republican, who rates four stars for unwavering support for keeping cyberspace free of taxes, favored a permanent ban, but a four-year extension keeps Internet users at arm’s length from the Internal Revenue Service and local tax collectors for least the foreseeable future.

The fight for a tax-free zone on the Internet was tougher than it should have been, because a handful of Republican senators wanted to empower states and cities to tax access to the Internet at their discretion. Freshman Sen. Lamar Alexander of Tennessee and a former governor, led the crusade for states, localities and brigades of special interest groups who receive the largess of local governments who all desperately wanted to tap this new cash cow of the Internet. Mr. Alexander was unfortunately joined by four other Republicans who wanted to allow local governments to impose a tollbooth on the Internet: Mike Enzi of Wyoming, George Voinovich of Ohio, Kay Bailey Hutchinson of Texas and Thad Cochran of Mississippi.

Lamar Alexander’s Internet access tax proposal would have done real damage to the U.S. economy at the very time it is getting its feet back under itself from the tech implosion in 2000-01. In this nascent recovery, growth is again being propelled by technology and knowledge-based industries. Free market advocates argued the Internet should be treated as a tax- and regulation-free form of commerce rather than an ATM machine for government officials to fund favored programs.

Back in 1998, Congress wisely declared the Internet a Tax Free Zone by establishing a moratorium on such Internet access charges. An “access charge” is just the government’s polite way of adopting a new tax. The idea was to prevent the government from causing infant crib death of this new consumer technology. After all, as Justice John Marshall once observed, “The power to tax is the power to destroy.” By all accounts, the Internet tax moratorium has been a resounding success. In 1985, about 1 in 6 American families and businesses had access to the Web, now 3 in 4 do.

E-commerce is the new frontier of business enterprise. International Data Corp. recently estimated the Internet economy in 2003 reached $2.8 trillion. In the U.S. alone e-commerce accounted for $500 billion in business activity and employed 2.3 million Americans. The Internet sector of the economy is growing 12 percent per year compounded.

E-commerce, in short, is to the early 21st century what the steam engine was to early 20th century economic development. Meanwhile, the telecommunications sector of the economy now stands ready to invest billions to upgrade the nation’s communications networks and make high-speed (or broadband) Internet access available to all American homes and small businesses, as it is for large corporations today. The tax ban extension will facilitate that infrastructure investment.

Opponents of the Internet tax ban always had it wrong. They argued this policy unfairly deprives state and local governments who need the money to fund vital public services. Mr. Alexander has labeled the federal ban on the Internet access taxes an “unfunded mandate on states.”

But an unfunded mandate is a federal requirement that states and localities spend money. This policy doesn’t even deny states and cities a traditional revenue source.

Most importantly, the growth of the Internet and the information economy has been an enormous net positive fiscal development for the states. In the 1990s, as the Internet economy soared, state and local revenues grew 3 times the pace of inflation. By the end of the 1990s, states and local government coffers were overflowing; it wasn’t until the tech bubble burst that government revenues sank.

Republicans and many pro-growth Democrats have done a service to taxpayers by extending the no-tax zone on the Internet, and the GOP really dodged a political bullet here. It would have made little sense for Republicans to run for re-election as the party that initiated the nation’s first-ever tax on the 74 percent of American households who use the Internet. That’s particularly true because these taxes already contemplated by some states and city hall could have cost families up to $150 a year.

But the victory for the Internet and for taxpayers last week only further postpones the bigger fight over whether Internet access and purchases should ever be taxed. Here is why the self-evident answer to that question is no. The expansion of the e-commerce world offers a one-time opportunity to erect a massive, global free trade zone, in which government regulations, fees and levies are banned.

What could be more liberating? Government power will shrink, as the information superhighway is further democratized over the next 20 years to reach every business and household in the world. This is precisely why so many advocates of big government want to tap into the power of the information age economy, before it renders them irrelevant.

So kudos to John McCain, George Allen and the White House for clearing away roadblocks to cyberspace future. It is also worth applauding Democrats such as Ron Wyden of Oregon who fought valiantly to keep politicians’ paws off the Internet. As Mr. Wyden said during the Senate debate: “Under [Mr. Alexander’s] proposal, the consumers would be taxed every time they send an e-mail, every time they read their local newspaper or check a bank statement online.” How sad that many Republicans in the Senate need to be lectured by Ron Wyden on the destructive impact of new taxes.

The House earlier this year passed a permanent ban on Internet taxes. When the Senate takes up the issue of making the Bush tax cuts permanent, it should add the Internet tax moratorium to the mix. An Internet tax won’t make any more sense five or 10 years from now than it does today.

Stephen Moore is a senior fellow a the Cato Institute.